Lower Rates Without the Fed?

Just days after his inauguration, President Donald Trump famously said, “With oil prices going down, I'll demand that interest rates drop immediately." And at a White House event following these comments, Trump said, "I think I know interest rates much better than they do, and I think I know it certainly much better than the one who's primarily in charge of making that decision," apparently referring to Federal Reserve Chairman Jerome Powell.

But in an about face, Trump in comments to reporters earlier this month said that the central bank was right to keep interest rates unchanged at its last policy meeting on January 29. "I'm not surprised," he told reporters. "I think holding the rates at this point was the right thing to do."

Also, newly confirmed Treasury Secretary Scott Bessent said the president no longer plans to pressure the Federal Reserve to lower its short-term federal funds interest rate. Instead, what he and the president want is to bring down longer-term borrowing costs, such as home mortgage rates, via a decrease in 10-year Treasury yields.

Today we take a look at the importance of Treasury yields, why President Trump has changed his tune and what measures the newly formed administration can take to ease long-term interest rates.

Treasury Yields Are Key

Treasury yields are a source of investor concern all over the globe. They are the primary benchmark from which all rates are derived. Treasury notes themselves are considered the safest asset in the world, given the depth and resources of the U.S. government.

The 10-year Treasury yield is a benchmark for other interest rates and a key indicator of investor sentiment about economic conditions. Important to consumers is mortgage rates which are often determined by adding a “spread” to the 10-year Treasury yield. This compensates investors for the higher risk of mortgages.

As the graphic below states, Treasury yields are affected mainly by three factors.

Graphic that list the economic factors that impact treasury yields

Interest rates. When the Federal Reserve lowers its key interest rate – the federal funds rate – it creates additional demand for Treasuries since they can lock in money at a specific interest rate. The increased demand causes Treasury bond prices to increase, which in turn causes their yields to fall.

Inflation. Inflationary pressures force central banks to raise interest rates to shrink the money supply. This causes investors to look for higher yielding investments to compensate for diminished purchasing power.

Economic growth. Strong economic growth usually leads to increased desire or demand for goods and services, which economists call aggregate demand. This usually leads in kind to an increase in goods and services produced, called gross domestic product (GDP). These two indicators often increase or decrease together. But if aggregate demand outpaces production, higher inflation ensues.

This ends our macroeconomic lesson for today! The point is these forces intricately combine to influence long-term bond yields.

Yields Not Following the Fed

At over 4.4%, yields on 10-year U.S. Treasuries are now about 80 basis points higher than their September lows of 3.65% — even though the Federal Reserve has been lowering its target policy interest rate. From our discussion above, we should expect Treasury yields to fall with interest rates. But they didn’t.

Here’s why that’s worth noting. In the previous seven cutting cycles by the Fed going back to the 1980s, the yield on the 10-year Treasury was lower 100% of the time 100 days after the first rate cut.

Graph showing how treasury yields typically drop when the fed cuts rates

At first glance, the above graph is a little confusing. The graph represents how the 10-year Treasury yield changed (in basis points) after the Fed began to cut interest rates. The grey lines are individual years from 1989 to 2019 during which the Fed cut interest rates. For our purposes, we don’t need to know which year is which. The important point to observe is that all grey lines trended downward. 10-year yields dropped within 100 days of the Fed’s first rate cut.

But 2024, which is represented by the blue line, shows a completely different story. 10-year yields increased after the Fed’s jumbo rate cut in September 2024. That upward trend continued into January 2025.

The question now is why 10-year yields are bucking historical trends. Economic uncertainty is a major factor contributing to the upward pressure on yields. Questions remain about where Fed rates will land over the next year or two, and what the new administration’s policies might mean for inflation and the Fed’s outlook. This is reflected in the 150 basis points of variance among FOMC members regarding where rates should settle in 2025 and beyond.

Copy of the Fed's dot plot that shows FOMC members are undecided on rates

Fiscal Policy Approach

The administration’s plan to reduce consumer long-term borrowing costs is to decrease the deficit, get energy prices down and raise GDP. Secretary Bessent’s economic plan dubbed “3-3-3” has been detailed in a previous newsletter (Bessent’s Plan: Flying High or Crash Landing?). His strategy is to focus on fiscal measures rather than pressuring the Federal Reserve to further drop interest rates.

To this end, the administration plans to:

Reduce government spending and increase efficiency
Cut the size of government
Make the Tax Cuts and Jobs Act permanent
Focus on deficit reduction

The administration believes lower energy costs will also help reduce yields by:

Expanding domestic oil production and energy exploration
Encouraging U.S. oil companies to increase drilling
Requesting OPEC to boost supply to lower prices

Will It Work?

Supporters of Bessent’s plan point to measures taken by the newly created Department of Government Efficiency (DOGE), led by Elon Musk, which have already increased confidence that the administration will reduce government spending. The labor market holds steady with the quits rate the lowest in five years and the January unemployment rate slightly dropping to 4.0%. The 10-year Treasury yield has responded to this. Currently it sits at about 4.45%, down from its mid-January peak of 4.8%.

Critics are not as optimistic. There remains much skepticism about deficit reduction, particularly in light of the administration’s desire to renew the 2017 income tax cuts. The U.S. has limited control over global economic factors, including OPEC’s resistance to increase oil production. Across the board tariffs have the potential to cause domestic consumer prices to rise, fueling further inflationary pressures.

We should have a good idea in the coming months of whether the administration is serious about implementing these measures. Lower home costs and decreased energy expenditures will certainly quell the last sticky holdouts in higher consumer price index (CPI) readings.

The president, Bessent notes, believes if the administration rolls back regulations, makes the 2017 Trump tax cuts permanent, and gets energy prices down, then rates "will take care of themselves." We’ll see.